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1. Stabilization of the Monetary Unit — From the Viewpoint of Theory (1923)

VII. The New Monetary System

1. First Steps

The bedrock and cornerstone of the provisional new monetary system must be the absolute prohibition of the issue of any additional notes not completely covered by gold. The maximum limit for German notes in circulation [not completely covered by gold] will be the sum of the banknotes, Loan Bureau Notes (Darlehenskassenscheinen), emergency currency (Notgeld) of every kind, and small coins, actually in circulation at the instant of the monetary reform, less the gold stock and supply of foreign bills held in the reserves of the Reichsbank and the private banks of issue. There must be absolutely no expansion above this maximum under any circumstances, except for the relaxation mentioned above at the end of each quarter. [See above pp. 29–30.] Notes of any kind over and above this amount must be fully covered by deposits of gold or foreign exchange in the Reichsbank. As may be seen, this constitutes acceptance of the leading principle of Peel's Bank Act, with all its shortcomings. However, these flaws have little significance at the moment. Our first concern is only to get rid of the inflation by stopping the printing presses. This goal, the only immediate one, will be most effectively served by a strict prohibition of the issue of additional notes not backed by metal.

Once adjustments have been made to the new situation, then it will be time enough to consider:

  1. On the one hand, whether it might not perhaps be expedient to tolerate the issue, within very narrow limits, of notes not covered by metal.
  2. On the other hand, whether it might not also be necessary to limit similarly the issue of other fiduciary media by establishing regulations over the banks’ cash balances and their check and draft transactions.

The question of banking freedom must then be discussed, again and again, on basic principles. Still, all this can wait until later. What is needed now is only to prohibit the issue of additional notes not covered by metal. This is all that can be done at present. Ideally, the limitation on the issue of currency could also be extended, even now, to the Reichsbank's transfer balances (deposits).24 However, this is not of as critical importance, for the present currency inflation has been and can be brought about only by the issue of notes.

Simultaneously with the enactment of the prohibition against the issue of additional notes not covered by metal, the Reichsbank should be required to purchase all supplies of gold offered them in exchange for notes at prices precisely corresponding to the new ratio. At the same time, the Reichsbank should be obliged to supply any amount of gold requested at that ratio, to anyone able to offer German notes in payment. With this reform, the German standard would become a gold exchange standard (Goldkernwährung). Later will be time enough to examine whether or not to renounce permanently the actual circulation of gold within the country. Careful consideration should be given to whether or not the higher costs needed to maintain the actual circulation of gold within the country might not be amply repaid by the fact that this would permit the people to discontinue using notes. Weaning the people away from paper money could perhaps forestall future efforts aimed at the over-issue of notes endowed with legal tender status. Nevertheless, the gold exchange standard is undoubtedly sufficient for the time being.25 The legal rate for notes in making payments can be temporarily maintained without risk.

It should also be specifically pointed out that the obligation of the Reichsbank to redeem its notes must be interpreted in the strictest possible manner. Every subterfuge, by which European central banks sought to follow some form of “gold premium policy”26 during the decades preceding the World War, must be discontinued.

2. Market Interest Rates

If the Reichsbank were operating under these principles, it would obviously not be in a position to supply the money market with funds obtained by increasing the circulation of notes not covered by metal. Except for the possibilities of such transfers as may not have been previously limited, the Bank will be able to lend out only its own resources and funds furnished by its creditors. Inflationary increases in the note circulation for the benefit of private, as well as public, credit demands will thus be ruled out. The Bank will not then be in a position to follow the policy—which it has attempted again and again—of lowering artificially the market rate of interest.

The explanation of the balance of payments doctrine presented here shows that under this arrangement the Reichsbank would not run the risk of an outflow of its gold and foreign exchange (Devisen) holdings. Citizens lacking confidence in future banking policy, who in the early years of the new monetary system try to exchange notes for gold or foreign exchange (Devisen), will not be satisfied with the assertion that the Bank will be required to redeem its notes only in larger sums, for gold bars and foreign exchange, not for gold coins. Then it will not be possible to eliminate all notes from circulation. In the beginning a larger amount [of foreign currencies and metallic money] may even be withdrawn from the Bank and hoarded. However, as soon as some confidence in the reliability of the new money develops, the hoards of foreign moneys and gold accumulated will flow into the Bank.

The Reichsbank must renounce every attempt to lower interest rates below those which reflect the actual supply and demand relationships existing in the capital markets, and thus encourage the demand for loans which can only be made by increasing the quantity of notes. This prerequisite for monetary reform will evoke the criticism of the naïve inflationists of the business world. These criticisms will grow as the difficulties of providing credit for the German economy increase during the coming years. In the view of the businessman, the role of the central bank of issue is to provide cheap credit. The businessman believes that the Bank should not deny newly created notes to those who want additional credit. For decades, the errors of the English Banking School theoreticians have prevailed in Germany. Bendixen has recently made them popular through his easily readable Theorie der klassischen Geldschöpfung.27

People keep forgetting that the increase in the cost of credit—which has become known by the very misleading term, “scarcity of money”—cannot be overcome in the long run by inflationist measures. They also forget that the interest rate cannot be reduced in the long run by credit expansion. The expansion of credit always leads to higher commodity prices and quotations for foreign exchange and foreign moneys.

  • 24. See p. 26 above. [NOTE: The German term is “Giroguthaben.” In Germany the “giro” banking system prevailed whereby depositors, instead of writing checks, authorized their banks to transfer specified sums to the accounts they wished paid.—Ed.]
  • 25. [In view of Mises's comments here, it appears that he then intended that the Reichsbank redeem at this point only larger sums of marks in gold and foreign exchange. Mises's insistence in later years on a gold coin standard, with gold coins in daily use, even in the early stages of monetary reform, represents a significant refinement of these earlier recommendations. See Human Action, chapter XXXI, section 3, and his 1953 essay, “Monetary Reconstruction,” the Epilogue to The Theory of Money and Credit, 1953, pp. 448–52; 1980, pp. 490–95. Also above, p. 20, note 14.—Ed.]
  • 26. [In The Theory of Money and Credit (1953, pp. 377ff.; 1980, pp. 416ff.), Mises describes the “gold premium policy” of making it difficult and expensive to obtain gold—by hampering its export through the manipulation of discount rates and by limiting the redemption of domestic money in gold.—Ed.]
  • 27. [Apparently works of Friedrich Bendixen (1864–1920) are not available in English language translations.—Ed.]